What are Inflation-Indexed Bonds?

They are bonds where the principal is indexed to inflation and are thus designed to cut out the inflation risk of an investment.

Inflation-indexed bonds pay a periodic coupon that is equal to the product of the inflation index and the nominal coupon rate. A rise in coupon payments is a result of an increase in inflation expectations, real rates, or both.

Also known as real return securities, it is a type of security that guarantees a return higher than the rate of inflation if it is held to maturity. Inflation-indexed securities link their capital appreciation, or coupon payments, to inflation rates. Investors seeking safe returns with little to no risk will often hold inflation-indexed securities.

These real return securities usually come in the form of a bond or note, but may also come in other forms. Since these types of securities offer investors a very high level of safety, the coupons attached to such securities are typically lower than notes with a higher level of risk. There is always a risk-reward trade-off for investors to balance.